Equity investing strategies

What do we understand by passive investment strategies in the markets? To put it simply, passive strategies are the opposite of active strategies. In active investing, the fund manager or the portfolio manager takes immense pain in doing in depth research into companies and identifying stocks that can outperform the market. The cost of active investing is much higher. Therefore the return expected on active investment funds is also much higher. So what is passive investing, and what are the best passive investment strategies? What are the various types of passive investment strategies? Passive investing does not try to beat the market but just tries to mirror the market. So you earn as good or bad as the index (Nifty or Sensex). But why is there a shift towards passive investing globally? Above all, what are the passive investment strategy benefits? The big shift towards passive investing. The big merit of passive investing is that the costs are much lower. You do not require analysts to identify stocks, and you do not require dealers and fund managers to create alpha. These lower costs get passed on to the end customer. Passive funds have been getting massive inflows in the last 10 years, but what has reversed is that active funds are seeing massive outflows. As Buffett pointed out in his 2017 letter to shareholders, passive funds are increasing, giving a tough time for active funds due to a combination of limited alpha opportunities and the substantially lower costs of passive funds. It is hardly surprising that two of the largest asset managers in the world, Blackrock and Vanguard (that jointly manage nearly $9 trillion between them), are essentially passive investors. So why has this shift towards passive investing happened so sharply? Why this shift towards passive investing globally? The passive index has outperformed more than 90% of the active fund managers. The real challenge for an investor is choosing a fund manager who will fall in the balance of 10%. That is why passive investing is becoming a lot more popular among investors. The point is why investors should opt for active funds when the outperformance ratio is so low, and there is no sure-shot method of identifying these outperformers. Types of Passive Investment Strategies As the name suggests, passive investing is all about tying your portfolio to an index or an ETF. There are four ways of creating a passive investment strategy in the Indian context. You can have a passive approach even in direct equities. An equity investor can create a passive strategy by buying up all the index stocks in the same proportion as the index. By doing that, your portfolio performance will approximately reflect the index's performance (Nifty or Sensex) over a longer time. The real challenge is something different for an individual that can be quite complicated as he will have to track index changes, weightage changes, corporate actions, etc. A simpler way to replicate the above will be to directly buy an index fund, which many mutual funds offer in India. An index fund buys up the entire index stocks in the same proportion as the index. The fund manager manages the tracking error and ensures that the fund performance is as closely aligned to the index. Index funds can be bought from mutual fund houses, distributors, or even online. The big advantage of index funds is that costs are very low compared to active funds. ETFs are a slight variation of the index fund. Like an index fund, the ETF also creates a portfolio of index stocks in the same proportion. The only difference is that the ETF is listed on a stock exchange and can be bought and sold on any recognized stock exchange. When you buy or sell an ETF, it only leads to a transfer of ownership and not to shift in the AUM of the ETF. Additionally, ETFs are also available on other benchmarks like ETFs on gold, ETFs on silver, ETFs on equity indices, ETFs on debt market indices, etc. ETF units can be bought and sold through your existing equity trading account. They can be held in your regular demat account. A slight variation of passive investing entails buying and holding a portfolio of dividend-yield stocks. Dividends are tax-free for the investor up to a limit. Thus a stock that offers a dividend yield of 6% will be paying an effective tax-adjusted return of {6%/(1-0.3)} = 7.14%. Most high dividend yield stocks are saturated stocks, and hence the volatility risk is quite low in such stocks. The moral of the story is that investors are beginning to see a lot of wisdom in passive investments like ETFs and index funds. They give you lower costs and also mirror macro market returns. The choice is yours, how you want to create a passive portfolio. Active investing What are Investment Strategies ? Investment strategies assist investors in determining where and how to invest based on their risk appetite, expected return, corpus size, retirement age, long-term vs. short-term holdings, industry preference, and other factors. Investing plans can be strategized based on the objectives and goals investors want to achieve. Investment strategies aren’t static, and they must be reviewed regularly as circumstances change. - Value Investing Investing in value stocks is a strategy that involves purchasing undervalued stocks of solid companies and holding them for a long time. This investing strategy aims to find high-quality and efficient companies that are currently undervalued, and this decision is based on solid fundamental analysis. In the classic book “The Intelligent Investor, " Benjamin Graham coined the term value investing and is also known as the “Father of Value Investing.” Warren Buffett, who followed Benjamin Graham, mastered value investing, eventually becoming the world’s wealthiest investor. Every stock has an intrinsic value, or what its real worth is. An investor can find a company’s real worth (intrinsic value) by conducting a fundamental analysis. The goal is to purchase stocks trading at a substantial discount to their intrinsic value (i.e., they are cheaper than their real value). When you buy an undervalued stock, the price rises to its intrinsic value over time, resulting in a long-term profit. Value stocks are typically associated with long-established companies with consistent growth rates, comparatively stable revenue, and consistent profitability. Investing in value stocks is not intended to become wealthy overnight. - Growth Investing Stocks expected to grow faster than the average rate of the industry in each country are known as growth stocks. Faster growth indicates that the company’s revenues and profits are expected to grow faster than the industry average due to various factors. Business is operating in an industry that is growing at a very fast rate and is faster than the industry's average growth rate, owing to increased penetration or adoption among its customers. The company has innovative products or services that catch up to its market peers faster than its competitors, giving it a competitive advantage. The company uses new technologies that are more productive and efficient than existing technology, giving it an advantage over the competition and driving increased adoption. These are just a few of the many factors that can cause a company’s growth to accelerate. For example, oil marketing companies typically do not provide strong growth over oil prices, which fluctuate according to crude oil prices and regulations, adding to a lot of volatility rather than one that adds value per unit sold. On the other hand, most NBFC participants have experienced higher-than-average growth in financials and stock price movement. Growth stocks cannot maintain their growth rate indefinitely as technology and trends change. These companies can provide investors with higher returns for a longer period, such as 10-15 years, as they penetrate and gain market share rapidly and generate strong profitability as the market develops and matures around them. - Momentum investing This strategy relies on the belief that the market has a persistent trend. By identifying and investing in assets with positive momentum, investors can ride the upward trend and achieve favorable returns. Principles of Momentum Investing Trend-following approach: Momentum investors seek to identify assets that have demonstrated strong price performance over a specific period, such as three to twelve months. The strategy assumes that these assets will continue their upward trajectory soon. Emphasis on relative strength: Momentum investing focuses on the relative strength of an asset compared to its peers or a benchmark index. Assets that consistently outperform their counterparts have strong momentum and are preferred for investment. Short holding periods: Momentum investing typically involves shorter holding periods. Risk management: Momentum investors often employ risk management techniques, such as stop-loss orders or trailing stop orders, to protect against potential downside risk if the momentum reverses. Example of Momentum Investing in India During the pandemic, domestic pharmaceutical companies have seen massive price increases. The Nifty Pharma index has increased by 40% in 2020, indicating the superiority of pharmaceutical stocks. Many investors jumped on board to capitalize on the trend and make quick gains. This strategy to go along with the market trend is called momentum investing. - Contrarian Investing The world was rocked by a terrible financial crisis in 2009. Investors panicked, and stock markets all over the world crashed. The outcome of this was huge selling by investors in the market. Similarly, when investors are happy, the markets may continue to rise. But this bubble eventually bursts. Herd mentality is exemplified. A significant number of investors blindly follow the investment strategies of seasoned investors. This is why many investors choose to go against the market trend rather than follow the herd. This strategy is called Contrarian Investing. Warren Buffett is the most vocal supporter of this strategy. Warren Buffet’s famous quote is, “Be greedy when others are fearful, and fearful when others are greedy”. When you hear that a company’s stock is performing well, you want to buy it. Similarly, any negative news may cause investors to panic and overreact to the news and eventually sell their stocks. This frequently results in an overvaluation of a stock. In this case, the share price does not reflect the stock’s real worth or intrinsic value. Stocks almost always fall or rise to their true value in the long run. The contrarian investor recognizes the disparity between the current share price and its true value. This encourages him to invest in an otherwise unpopular company. - Income Investing Rather than investing in stocks that only increase the portfolio's value, this strategy focuses on generating cash income from them. An investor can earn two types of cash income. Dividends from equity and fixed interest income from bonds. This strategy is chosen by investors who want a steady income stream from their investments.Picking the stocks with the highest dividends is not the right strategy. That may seem counterintuitive, but companies often pay large dividends for a reason. There could be underlying business issues, which can cause hindrances to the company's future growth. - Active Investing Active investing is a hands-on approach. Active money management seeks to outperform the stock market by exploiting short-term price fluctuations. It necessitates a more thorough examination and understanding of when to enter or exit a specific stock, bond, or other asset. Active investors must monitor both qualitative and quantitative factors of the stocks. Conclusion There are a variety of investment strategies that suit different risk profiles, involvement, and timing. Understanding your preferences and financial situation is key to determining the best strategy. An investing strategy that works for someone might not work for you. When it comes to investing, there is a lot at play, and it is better to consult financial advisors to help you with investment strategies.